Construction mortgages

By Kimberly GreeneFont size :

A construction mortgage is exactly what it sounds like: a mortgage that covers the cost of the construction of your home. As you might imagine, they differ from other types of mortgages in a number of ways.

Completion mortgage

There are two types of mortgages that you can get when you are buying a home. The first is known as a completion mortgage, under which the loan isn’t transferred until construction is complete – or at least, until you take possession of your home. You may still be required to come up with a down payment, although it may be payable in installments. Because payment isn’t made until the construction is complete, you can usually make desired changes to the mortgage up until 30 days before your possession date, such as increasing the mortgage to allow extra money for any upgrades or additions that you may end up choosing along the way.

Although a completion mortgage can give you some peace of mind that the mortgage won’t be finalized until you have something in exchange – a bricks and mortar home – there is also the uncertainty that anything could take place between now and then. That’s good if something were to change on the builder’s end to delay construction, but not so good if the change takes place on your end and your life circumstances take a turn for the worse. If you change jobs or get a new loan, for example, your mortgage approval could be in jeopardy. Depending on the length of time estimated for the completion of your build, you might not want to make that kind of commitment. The good news is that if you want a completion mortgage, you probably won’t have to wait that long; most lenders who do these types of mortgages want the build to be completed within 120 days.

Draw/Progress-draw mortgage

The second type of construction mortgage that you can get is called a draw or a progress-draw mortgage, which allows the builder to draw money throughout the building process. With a progress-draw mortgage, the loan is being dispersed in increments: the first, when the build begins; the second, around 35-40 per cent; the third, around 65-70 per cent; and the last, which is close to or at 100 per cent finished (otherwise known as the “foundation, lock up, drywall, and completion” stages). The progress-draw option is also available if you’re building your own home and need money throughout the process.

The progress-draw mortgage is beneficial from a cash flow perspective, as the builder doesn’t have to come up with the money for the build upfront without getting anything in return. An inspection is required throughout the building process to ensure that things are on schedule and done properly, and if the build doesn’t pass inspection then the builder doesn’t get the next payment. While these visits are great for keeping things on track, you’ll have to pay an additional fee each time the appraiser makes an appearance. With the progress-draw mortgage, you may be charged interest from the date you make your first payment, and you aren’t able to change the mortgage once your lender advances the initial payment.

A construction mortgage must be secured by the land in addition to its improvement value, which combines to make up the total value of the project. If the plot of land has little or no mortgage, then the builder is able to receive the first draw of financing at once, known as the initial ‘foundation’ draw. If that’s not the case, you’ll have to pony up that cash yourself until the first disbursement of the loan, which is around 35-40 per cent. So if one of the main motivators for you building a home is to help keep your costs down, remember that you are likely going to be required to come up with a significant amount of money upfront, and as anyone who has experience working with construction and renovation of any kind will tell you, that amount of money has a tendency to increase, especially when estimating costs for material and labour, and planning for unforeseen circumstances.

Vacant land

If you’re building from scratch on your own and need a loan to purchase the land separately, you may need a different type of loan to buy the land – a step that generally doesn’t apply if you’re buying a home through a builder. Even with ample income and good credit, a loan for a piece of vacant land may come with high interest rates and require a large deposit that could range anywhere from 25 per cent to 35 per cent. Private lenders are another way to get loans for vacant land, as well as personal lines of credit – or home equity lines of credit (HELOCs) if you have equity in another property that you’re able and willing to use for the land.

When buying land, do your due diligence beforehand to ensure that you will be allowed to build the property that you want on that particular piece of land. Some things to consider: the source of water and wastewater removal on the property; how the land is currently zoned/owned/partitioned; current environmental concerns with the property that might need mitigating; and the availability of utilities and other amenities.

Mortgage process

As you might imagine, the process of getting a mortgage can be a little trickier compared to more typical mortgages. Some lenders have limitations regarding the length of time necessary for the build and won’t lend you money if you expect the build to go on for longer than their specified date. You may also need an estimate when it comes to construction costs – including the land, if that hasn’t been purchased already.

You may also be restricted when it comes to the builder you choose. If you go with TD construction financing, for example, “The builder/contractor and the property must be registered under the applicable provincial New Home Warranty programs. TD Bank will require a builder with a satisfactory record, and he or she must provide a fixed price for the completed project. If a contractor (or you as the owner) is planning to construct the house, you will need to consider the contractor's ability to complete the project and any work you yourself may intend to undertake on your own.”

Typically, completion mortgages aren’t a big deal to lenders. Because the loan isn’t finalized until the build is complete, there’s no more risk to them than there would be for any other type of residential resale property. Progress-draw mortgages, however are much riskier. Yes, a lender charges you interest on your mortgage, but their real fallback plan in the event that you default on your loan is to repossess your home and then sell it in order to get their money back. With a progress-draw mortgage, that will be much harder to do effectively since the building may or may not be complete. Not only is there an increased possibility that it will take longer to sell the home, but the value of the home itself is also uncertain if it’s not completed.

The completion mortgage works similarly to a mortgage obtained for the purchase of a resale home, except it’s arranged in advance. Some lenders will even allow you do to a combination of the two loans – where you start with the progress-draw and then move to a completion mortgage at a later stage of the process. Another option is to convert to a long-term, traditional mortgage once the construction of the home is complete.

Speaking to a mortgage broker who specializes in construction will clear up any concerns you may have, and help you explore all of the options available to you based on your goals. This way, you’ll avoid getting invested in building your dream home, only to have your heart broken when you can’t pay for it.

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